What is Equity Interest?
Why is it so important in business?
What are the essential elements you should know!
In this article, I will break down the notion of Equity Interest so you know all there is to know about it!
Keep reading as I have gathered exactly the information that you need!
Let’s see what equity interest means and why it’s important!
Are you ready?
Let’s get started!
Table of Contents
What Is Equity Interest
Equity interest refers to a person or a company’s ownership of a business.
In other words, “equity interest” means the same thing as “business ownership”.
For example, a shareholder of a company holding common shares or preferred shares is considered to have an equity interest in the corporation.
A partner of a partnership will be considered to have equity ownership in the partnership.
Similarly, a member of a limited liability company will be considered to have an ownership interest in the LLC.
The ownership interest in a business can also be expressed as a function of the percentage owned by a person or entity.
For example, if four shareholders in a corporation each hold 25% of the issued and outstanding common stock, they are considered to have a 25% equity interest in the corporation.
To better understand the notion of equity interest, let’s break it down into its components “equity” and “interest”.
According to Investopedia, equity is defined as:
Equity, typically referred to as shareholders’ equity (or owners’ equity for privately held companies), represents the amount of money that would be returned to a company’s shareholders if all of the assets were liquidated and all of the company’s debt was paid off in the case of liquidation.
In business, to refer to equity, you are generally referring to a shareholder’s equity (also an owner’s equity in a private company) representing how much money or value the owner may potentially get if the company was sold or liquidated.
According to the Merriam-Webster dictionary, interest is defined as:
Right, title, or legal share in something
In other words, to have “interest” in something means that you have a legal right, share, title to a property, asset, or business.
Equity Interest Definition
According to the AccountingTools, equity interest is defined as:
Equity interest is the ownership share of a shareholder in a business. For example, having a 15% equity interest in a company means that a shareholder owns 15% of the business.
The SEC has the following equity interest definition:
“Equity Interest” means with respect to any Person, any shares, interests, profits interests, participations, or other equivalents (however designated) of corporate stock, membership interests or partnership interests (or any other ownership interests) of such Person.
As defined in NCS Multistage Holdings, Inc. Form 8-K/A filing.
As you can see from this definition, equity ownership interest can be summed up as:
- Share of ownership
- In a business
Based on the definition of equity and interest that I’ve presented above, I’d define equity as follows:
Equity interest refers to a person or entity’s legal title or legal interest in a business equivalent to an ownership interest in a property or assetAs defined in NCS Multistage Holdings, Inc. Form 8-K/A filing.
Types of Equity
In addition to the notion of legal interest in a company’s net worth, the notion of equity can have different forms and applications as well.
Let’s look at how the notion of equity can be used in different areas and industries.
In accounting, equity can refer to a shareholder’s equity on the balance sheet representing the amounts contributed by the shareholders along with the company’s retained earnings or losses.
Traders may use the term equity to refer to the value of the securities they hold in their brokerage account.
In the context of real estate, equity refers to the fair market value of a property less the total outstanding debt or mortgages payable to a creditor.
In bankruptcy proceedings, equity refers to the amount of money left to pay equity interest holders after all creditors have been paid off following the liquidation of the company.
How To Acquire Equity Interest
For a person to acquire an equity interest in a corporation or business, it must acquire ownership units of the business.
Depending on the nature of the company, the way you may acquire an equity interest may vary.
If a company is listed in the stock exchange (public company), you can buy equity by buying shares of stock through a stockbroker your by yourself if you have a brokerage account.
If the corporation is private, you can negotiate with the individuals having control over the organization to get shares of stock issued to you from the company’s share capital or have the current shareholders transfer a portion of their shares to you.
If the entity is a partnership, you must negotiate with the current partners who must approve to include you as a new partner in the business.
If the entity is a limited liability company, you must negotiate with the LLC members to acquire an equity interest in the LLC.
Ownership Interest Rights
As a business owner or shareholder, equity holders have certain rights and privileges in the business.
A common shareholder of a corporation generally has the following rights:
- The right to vote to elect the members of the board and on important company decisions
- The right to receive dividends if any are declared
- The right to receive liquidation proceeds if the company is wound up
What’s also important to keep in mind is that equity shareholders or equity interest holders will benefit from the increased value of the business over time (but can also lose their equity value if the company goes bankrupt).
When an equity holder sells his or her shares, it will either generate a profit (capital gains) or losses (capital losses).
If the equity holder receives dividends, the dividend will be reported as an income on the shareholder’s income tax report for that year.
Equity Interest Example
Let’s look at an example of equity interest to better illustrate the concept.
Imagine that you have a small business operated under a corporation where you are the sole owner.
In that case, as as the only shareholder of the company, you have all the equity interest in the corporation.
Now imagine that an angel investor or private equity firm is interested in investing some money into your business and wants an equity stake in the corporation.
In exchange for the angel investor’s funding, transfer 25% of your common shares to the investor.
As such, the investor acquires an interest in equity in your corporation amounting to 25% of the total and outstanding shares.
It’s also a good idea to talk about equity interest rates in our example.
An equity interest rate is an amount that equity investors earn on their inquiry investment.
The more a company is able to generate profits, the more the investors’ equity interest rate goes up.
Since equity represents the residuary interest in a company (all assets minus all liabilities), the rate of return calculations may vary depending on what earning or equity value the investor uses (such as total earnings, accrued earnings etc).
Equity vs Ownership
What is the difference between equity interest and ownership interest?
Equity interest is generally a phrase used to refer to the interest of shareholders (common shares or preferred shares) in a corporate.
In essence, “equity interest” means that someone or some company has legal ownership of all or part of the shares in a legal entity (a corporation for example).
You can say that ownership interest in a corporation is synonymous with an equity interest.
Ownership interest, although it means in substance the same thing as an equity interest, is broader in scope.
In other words, the ownership interest definition can encompass any type of property, asset, or type of ownership over and above an equity type of interest.
In a business context, however, many will use the phrases ownership interests and equity interests interchangeably.
Equity Interests Takeaways
So there you have it folks!
What does equity interest mean?
What is an ownership interest in a company?
In a nutshell, equity interest can be defined as the shares a person or company owns in a corporation or a legal entity.
For example, in the business world, when someone refers to outstanding equity interest, it is referring to outstanding shares in a corporation.
You can say that “equity” interest is the level of interest a person (or another entity) has in a company.
When speaking about corporations and companies, equity interest is defined as the percentage of shares issued to an individual by the company giving that person equity rights.
An equity shareholder has the right to participate in the earnings of the corporation (but will also suffer lose its equity investment if the company goes bankrupt).
In the end, to have equity interests is to have shares in the capital stock of a company or have some form of ownership interest in a business.
I hope that I was able to clarify the meaning of equity interest for you!
My Investing, Business, and Law Blog
By the way, on this blog, I focus on topics related to starting a business, business contracts, and investing, making money geared to beginners, entrepreneurs, business owners, or anyone eager to learn.
I started this blog out of my passion to share my knowledge with you in the areas of finance, investing, business, and law, topics that I truly love and have spent decades perfecting.
You may find useful nuggets of wisdom to help you in your entrepreneurship journey and as an investor.
I’d love to share the insider knowledge that I’ve acquired over the years helping you achieve your business and financial goals.
Now, let’s look at a summary of our findings.
Equity Ownership Summary
If you enjoyed this article on Equity Interest, I recommend you look into the following terms and concepts. Enjoy!
You May Also Like Related to What Is Equity Ownership
Cash flow forecast
Internal rate of return
Return on common equity
Revenue vs income
Related to Business And Shares Interest
Asset to equity ratio
Asset turnover ratio
Debt-to-equity ratio (D/E)
FHA cash-out finance
Net profit margin (NPM)
Return on equity (ROE)
Shareholder equity ratio
Weighted average cost of capital (WACC)